Don't Panic Over the FCC Proposal to Levy Fees on Internet Telephony
By R. Beck - 4/06/98
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Although Internet telephony investors are understandably nervous about the FCC proposal, panic is clearly not justified. While the report is still in the draft stage, Internet telephony advocates should be reassured by recent speeches by Commissioner Susan Ness as well as the FCC's long history of resisting pressure to outlaw or regulate Internet telephony. In a February 9 speech, Susan Ness stated that long distance carriers pay excessive fees to use the local phone networks and that the goal should be lower them as opposed to expanding their coverage to ISPs. At the same time, the FCC is also keenly aware that Internet phone calls should pay, like traditional phone calls, for using the local phone network. This suggests that the FCC proposal will most likely require Internet phone calls to pay fees, but considerably less than what long distance carriers currently pay. If this happens, then domestic Internet phone calls would still be significantly cheaper than conversations placed over conventional phone networks. Indeed, the news is even better. The FCC proposal would not make a dent in the huge cost advantage enjoyed by international phone calls using Internet technology nor affect the attractiveness of placing calls on corporate Intranets using Internet phone technology. This article explains the economics of Internet telephony and shows how different possible versions of the FCC proposal would affect it.
A misconception worth correcting about Internet telephony is that these calls necessarily run over the Internet. This is not the case: an Internet phone call uses Internet technology and can be carried by the Internet or private networks devoted solely to providing phone service. Indeed, QWEST and AT&T are doing the latter: using private networks modeled on the Internet to carry conversations. IDT carries phone calls over its own Internet backbone.
Why use Internet technology to place a domestic phone call? Because it's cheaper largely due to government regulations. When a long distance phone call is made, the call goes through the local phone network to reach the long distance network and then goes through the local network again at the receiving end. The local phone companies levy charges on long distance phone calls for using their networks: these access charges make up over 50% of a long distance phone company's costs and total four cents per minute. Yet the local network cost of originating or terminating a long distance phone call is estimated to be only half a cent per minute. Local calls to an ISP or to an Internet phone company's network are currently exempt from access charges. Clearly Internet phone calls use the local phone network and should help pay for it. But because the FCC is acutely aware that access charges are inflated, it is likely that the FCC will propose that Internet phone calls pay a one cent per minute fee, leaving them with three cent cost advantage over conventional telephony. The other important issue that the FCC will address in their proposal is whether Internet phone companies should pay a long distance phone revenue tax into the universal service fund. This fund subsidizes rural local phone service, phone service for the poor, and provides funds to connect schools and hospitals to the Internet. Commissioner Susan Ness' March 30 speech suggests that Internet telephony providers will not receiver any break on the universal fund obligations. All of this suggests that the FCC will probably propose that Internet telephony providers pay access charges at cost and the standard universal service tax. This proposal would raise the domestic cost and price of an Internet phone by 1.5 - 2.0 cpm. Under these circumstances, a prominent player like IDT would have to raise its domestic rate from 5 cents to the 6.5-7.0 cent range to maintain its profit margin. Then the issue becomes whether the price-quality tradeoff is still attractive to customers.
While the FCC could destroy the market for domestic Internet phone service by imposing access fees equal to what AT&T and other carriers pay, this worse-case scenario would have little impact on the huge cost advantage of making international calls using Internet-style networks. When a conventional phone call is placed overseas, the American carrier usually pays a huge fee to the foreign carrier to terminate the call. These settlement fees can be as much as a dollar a minute, despite the foreign carrier's termination costs being at most two or three cents. However, Internet phone calls travel over data transmission lines that are exempt from paying these fees. Hence the settlement savings simply overwhelm any potential access or universal fund charges. To illustrate the savings possible by avoiding settlements, IDT offers calls to Australia, Sweden, and other countries for as little as ten cents, lower than the average price of a domestic interstate phone call. At worse the FCC proposal would raise these rates by several cents.
Another important market for Internet telephony are corporate Intranets. A large corporation can modify its Intranet and run intra-company voice and fax calls over it for as a little as a cent per minute. Companies like VocalTec and Netspeak are focusing their efforts on selling the hardware and software needed to convert corporate Intranets into voice networks. Since corporate Intranets connect company sites using special lines that bypass the local phone networks, access charges don't apply and the FCC proposal is a non-issue. Interestingly, both intra-corporate calls carried by the long distance networks and by Intranets bypass the local phone network and thereby avoid the associated access charges. Intranet calls are cheaper because they use spare network capacity. |
